Many of us had been enjoying the sunny weather and football — until last night — but it hasn’t been as much fun for sofa retailer DFS Furniture (LSE: DFS).
On Thursday morning the company issued a profit warning, blaming hot weather and shipping delays from the Far East. The company says orders during the current quarter have been “significantly lower than expected”.
This has contributed to a 4% fall in total like-for-like delivered revenues for the 49 weeks to 7 July (the firm’s financial year ends on 29 July). Earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to be lower than last year.
This could be serious
I’d normally write off today’s news as a one-off with little real significance. After all, customers planning to buy a new sofa are probably just waiting for a wet weekend to go shopping. Similarly, shipping delays are unlikely to be a long-term problem.
What concerns me here is that the fourth-quarter fall in sales continues a trend seen during the first half of the year, when revenue, excluding acquisitions, fell by 3.5%.
A second worry is that the business carries quite a lot of debt. Net debt was £172.3m at the end of January, equivalent to 2.17 times underlying EBITDA. That’s above my preferred safety threshold of 2x EBITDA.
Why I’d shun this stock
A look at the balance sheet suggests to me that DFS offers very little margin of safety for shareholders. In its half-year results, the group reported current assets — cash, stock and orders — worth £114.3m.
Set against this were current liabilities (bills due within one year) of £230.6m. In addition to this, the company had gross debt of £185.6m and £79.8m of “other liabilities”.
My reading of this is that DFS is dependent on stable sales to finance its debts and dividends. If sales and EBITDA fall, I believe the group could run into financial trouble. This would be bad news for shareholders, who could see big losses and might have to support a rights issue.
For these reasons, I view DFS as a stock to avoid. Although the forecast dividend yield of 5.8% may be tempting, I think there are much safer options elsewhere.
One consumer stock I’d buy
Furniture retailers aren’t the only consumer businesses which have seen a drop in sales during the hot weather. Travel firms have also seen lower levels of booking than expected. I expect this trend to reverse over the next few weeks, as people complete their summer holiday plans.
Although the good weather means that UK-based holidays might be more popular than usual, I believe that package holiday operators such as TUI Group (LSE: TUI), which owns Thomson Holidays, should still do well.
This firm has been my top pick in this sector for some time and has risen strongly, gaining nearly 40% over the last year. The good news is that the recent pullback in the share price has left the stock with a forecast dividend yield of 3.7% and a very reasonable forecast price/earnings ratio of 13.5.
This looks affordable to me, given that sales rose by 8.5% during the first half of the year. Bookings should peak over the next few weeks. In my view, this could be a good time to buy more.
